Tuesday, May 21, 2024

Don’t Trade Without These 2 Chart Patterns

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Editor’s Note: Chief Income Strategist Marc Lichtenfeld’s longtime followers know how much he relies on technical analysis – that is, studying chart patterns – as he evaluates stocks, sectors, commodities and more.

But if you’re newer to Wealthy Retirement, the concept of studying stock charts may be unfamiliar to you.

Either way, in today’s column, Marc will share with you two of his favorite chart patterns – one of which he just used yesterday to close out a nearly 300% win in his VIP service Technical Pattern Profits!

Chart: Grab 289% Gains on...

If you’d like to learn even more about how to use chart patterns to supercharge your nest egg, keep an eye out for Marc’s column next Tuesday. He’ll also be teaching you about his No. 1 favorite pattern. (Hint: It was once used to set a world record!)

– James Ogletree, Managing Editor


In the fall of 1999, I excitedly walked into a classroom. It had been a long time since I’d sat in one of those chairs with the little attached desks while a professor dispersed knowledge.

My career in finance was just getting started, but I was fascinated to learn how traders use technical analysis to try to make sense of why stocks and markets move in the directions they do.

Sure, a company that grows its earnings over the long term will see its stock rise. But what about all of those short- and intermediate-term moves that didn’t seem to align with the news? And even for long-term investments, how do you ensure you’re not putting money to work just before a stock slides?

Technical analysis has many ways of looking at the markets. You can use cycle analysis, sector rotation, all kinds of complicated signals. But for me, what made the most sense – and still does 25 years later – is simple pattern recognition.

A chart pattern is just a visual representation of human emotions in the market – namely fear and greed.

These patterns tend to repeat, which tells us that humans often react in predictable ways.

And we can clearly see that on this stock chart:

Chart: Chart showing Upper Channel Line and the Lower Trendline

This pattern is called an upward channel, but I call it a “Power Channel” in my VIP service Technical Pattern Profits. It’s marked by the stock rising along the lower trend line (also called an uptrend line) but getting capped at the higher channel line.

If you were looking at this stock in late January, when the stock was trading at over $140, you might’ve noticed that every time the stock had hit that upper channel line, there was a better buying opportunity shortly after. In fact, just a week or two later, you could have bought the stock at $135.

We don’t necessarily know (or care) why the stock sells off every time it hits the top line or why it rebounds when it hits the lower line. We just know that it does and that it’s repeatable – and we can use that to our advantage.

We also know that when the pattern changes, we ought to pay attention. If this stock had fallen below the lower trend line to $130 in February, that would’ve suggested that the pattern was broken and that we couldn’t rely on the stock rebounding back toward the upper channel line.

Another reliable pattern is the head and shoulders pattern. This is a very bearish signal that suggests demand for the stock is drying up.

Chart showing the head and shoulders pattern

A head and shoulders pattern occurs when a stock or market is rising and hits three peaks. After making the first peak (or left shoulder), the price declines a bit and then rises to a higher second peak, often on lower volume than it had for the first high. This second peak is known as the head. The price then drops again before climbing to a third peak that is lower than the second. Volume on this peak, the right shoulder, is lower than it was for the left shoulder or the head.

If all of these conditions are met, a head and shoulders pattern has formed. This is a strong sign that buying power is evaporating and that the bulls don’t have enough firepower to get the stock to a new high.

In his renowned Encyclopedia of Chart Patterns, Thomas Bulkowski looked at various chart patterns and quantified how successful they are at predicting stock moves. After studying 2,800 trades that displayed the head and shoulders pattern, he found that the average decline was 16% and the stock dropped 68% of the time when the pattern appeared.

That’s good information to know, because it tells you that if you notice a head and shoulders pattern in a stock’s chart, you’d be better off waiting and letting the price come back down. Or, if you’re an active trader, a stock in a head and shoulders formation would be a potential short candidate.

Whenever I discuss technical analysis, I always mention that stock charts and chart patterns are not crystal balls. But by understanding how human behavior repeats itself and how we can identify when those behaviors are occurring, we can greatly tip the odds of successful investing and trading in our favor.

All the best traders use charts and patterns. If you’re not using them, you’re leaving a lot of money on the table. Walking into that classroom (and several others after that) was one of the best decisions I ever made for both my career and my personal finances.

Good investing,

Marc

P.S. If you thought Power Channels and head and shoulders patterns were impressive…

Just wait until next week, when I tell you about my all-time favorite chart pattern.

In the Encyclopedia of Chart Patterns, Tom Bulkowski studied 307 instances of this pattern appearing in a stock’s chart…

And the stock moved higher every single time.

Plus, he wrote that this record-setting pattern “was the best-performing chart pattern in both bull and bear markets.”

Be sure to check out my column next Tuesday to learn more!





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