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What are the most profitable stock patterns?

Updated on 2012-10-06 by Guest





Value investors often base their recommendations by examining the fundamentals of a company. This is called fundamental analysis and it is the preferred technique for the long term. In the short term and to make profits from trading, technical analysis might provide you with better indicators of when to buy and sell a stock. Stock patterns are part of technical analysis.

These stock patterns have been identified by traders as working for them quite consistently. A lot of the stuff here comes from the book Encyclopedia of Chart Patterns (Wiley Trading) by Thomas N. Bulkowski. The book is a gold mine of facts and has reviewed 53 stock chart patterns.


The Rationale behind Stock Patterns

Let’s consider an example. This is all fictional. General Scooter’s stock’s price hit $40 a share recently and investors rushed to buy the stock. The stock price has since fallen to $30 and this has upset the investors that bought it at the $40 price. Just like any stock pattern, the stock starts an ascent again and when the prices gets close to $40, investors who bought it for $40 are tempted to sell so that they can at least break even.
A lot of market participants react the same way and at the $30, they will sell and this leads to a lot of selling. This causes the stock price to drop again. It will at some point get on an up trend despite hitting a few lows that will see the stock price go beyond the initial $40. And this is why stock patterns are such great additions to your investing tool kit.

The profitable stock patterns in a bull market and a bear market differ.


Profitable Stock Patterns in a Bull Market

Ascending Triangle:

This stock pattern is very popular among traders. It is recognizable as a horizontal trend and then an up trend that forms the shape of a triangle. The price target for an investor to sell is calculated by adding the stock’s lowest price in the pattern with the horizontal trend.
The problem with ascending triangles is that they can lead to losses if not identified correctly or if investment is delayed for any reason. Furthermore, this pattern occurs infrequently. At the same time, this stock pattern is one of the more profitable ones.

Reverse Head and Shoulders Pattern:

This is easily recognizable and signals to investors of possible stock trend reversals. This stock pattern encourages risk-taking behavior because Bulkowski’s study has found that it has a very low failure rate of 5 percent. The downside is that there is a good chance of making significant losses if it is not identified correctly.
However, this stock pattern occurs a lot and implies that the stock price will go up as a result of increased buying. The reverse head and shoulder pattern occurs mostly in a long term down trend, but it may also form in an up trend.

Double Bottoms:

There has been talk of a double dip recession and this is a similar idea with double bottoms in stock patterns. The way investors profit from double bottoms is to buy the stock only after it has hit the confirmation point showing that it is in fact a double bottom stock pattern.
It is easily recognized and occurs often. Still analysts find it difficult to correctly identify a double bottom.

Rounding Tops:

A Rounding Top forms an upside down “U”. In a bull market, a rounding top signifies to investors that it is time to sell as the stock will tank. There is still a chance that the price could go up after the rounding top completes.


Profitable Stock Patterns in a Bear Market

Descending Triangles:

This is the complete opposite of the ascending triangles stock pattern mentioned above. Investors profit from the descending triangle by shorting the stock. It's important to short on the initial break because the re-test that more than confirms this stock pattern is not a consistent occurrence.
The descending triangle occurs infrequently. Therefore investors should be on the lookout for it as it will make it worth their while. It is definitely a profitable stock pattern that traders should include in their investing tool kit.

Head and Shoulder Tops:

This is a three peak stock pattern that is easily identifiable with the middle peak being the highest of the three. This stock chart pattern has a low failure rate and when investors see the right shoulder forming on the chart, it is time to close all the long positions and short the stock.
A good understanding of the head and shoulder top stock pattern pays off big time since it occurs fairly often. Investors love this profitable stock pattern because it is so reliable.

Descending Scallops:

The shape of the descending scallop appears to be that of a backward letter J. Traders calculating the price target can do so by first measuring the difference between the high and the low in the stock pattern. This difference is multiplied by the percentage meeting price target of descending scallops of 30-35 percent as found by Bulkowski's study. This result should be subtracted from the lowest valley to get the price target.

Broadening Bottoms, Down Breakout:

The broadening bottom stock pattern happens quite frequently. Investors will short sell the security after it has a down breakout. The shape of this stock pattern on the chart is that of a megaphone. It has higher peaks and lower valleys. The price trend is obviously downward most of the time which makes bears love this profitable stock pattern.


Conclusion

The best way to take advantage of these profitable stock patterns is to commit to these well founded trading disciplines. Investors find it hard to do precisely this because emotion gets in the way and this is not good for stock market trading success.

fundamental analysis needs to be complemented with an effective stock pattern strategy to maximize trading profits and to eliminate losses. A warning for investors is that improperly using any of these stock patterns will result in losses as is the general case with stock market trading that comes with a lot of risk.









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