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(6) How to use point and figure trading techniques.
(7) How to use the RSI indicator.
(8) How to correctly use stochastics in your trading.
(9) How to use the ADX indicator to capture trends.
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Friday, August 28, 2009

TRIPLE TOP PATTERN – Part 2: Important Characteristics

Go back to Part 1: Triple Top Formation.

Important Characteristics of Triple Top Pattern
Existing Trend:
There should be an established existing UPWARD trend prior to the pattern.

Shape of Triple Top Pattern:
1) The Three Peaks:
The peaks / tops should be sharp and distinct / well separated. The price peaks do not have to be exactly the same, but it should appear reasonably equivalent to each other.
If the last top (3rd peak) is lower than the middle top (2nd peak), there is a relatively higher chance of stronger decline. A lower top in the last peak might indicate weaker buying sentiments, as the buyers attempt to reach the previous high or make a new high but fail, suggesting that the buyers might have been drying up & exhausted.

2) The Two Troughs:
The lows of the troughs can appear more rounded.

Duration:
Triple Tops pattern can be considered a long term pattern.
The duration of the formation of the pattern can take several months, normally range from 3 to 6 months, with an average of about 4 months.
Basically, the longer the time duration the pattern takes to develop, the more likely the pattern could work out as a reversal pattern or the stronger the price might move once the breakout occurs.

Breakout:
Even when the price has declined from the 3rd peak, the pattern is not completed yet. The chances that the existing uptrend will continue are still higher than the chances of reversal to take place, as it is normal during an uptrend for the price to test a resistance level a few times, then retreat, and then resume the uptrend again.

Triple Top pattern is only completed and confirmed when the price declines and closes below the lowest lows of the troughs in between the 3 peaks, which serves as the key support level in this pattern. This lowest low is called the “Confirmation Point”.

Remember that we should always assume the existing trend (i.e. in this case is uptrend) is in force unless proven otherwise.
Therefore, it is important to wait for the price to make a decisive breakout by breaking through and closing below the Confirmation Point, accompanied with an increase in volume, in order to avoid jumping the gun and/or prevent deceptive Triple Tops pattern.

In addition, as Triple Tops is forming, the formation may also resemble few other patterns. Before the 3rd peak is formed, the pattern may look like Double Tops (reversal pattern). The three equal highs may also be seen in Rectangle pattern (neutral pattern) or Ascending Triangle pattern (bullish continuation pattern).
Nevertheless, all these patterns have similar principle to follow, which could help differentiate between the above patterns or avoid jumping the gun: Always wait for the decisive breakout to occur before entering into any trade.

Breakout Confirmation:
Sometimes, the price may also make a deceptive/invalid breakout whereby it touches below the Confirmation Point, but then it moves back up again & resumes uptrend.
One possible way to prevent this is by having certain criteria to confirm if the breakout is a valid one.
A minimum penetration criteria for a breakout should be the price closes BELOW the Confirmation Point, not just an intraday penetration.
Some traders may apply certain price criteria (e.g. 3% - 5% break from the Confirmation Point depending on the stock’s volatility) or time criteria (e.g. the breakout is sustained for 3 days) to confirm the validity of the breakout.

Volume:
Volume should be higher during the formation of the 1st peak and then get lighter as the pattern develops the subsequent two peaks, showing an indication that the buying pressures are getting weaker.
The volume may sometimes pick up when the price hits each of the peaks, but overall, volume tends to be diminishing as the pattern is forming.
During & after the breakout of the Confirmation Point, the volume should significantly increase again.
When during the decline from the 3rd peak, the price experiences an accelerated drop, perhaps with a gap down or two, accompanied by an expansion in volume, this might give a good sign, as the price decline tends to drop further, and hence it may provide higher chances that the pattern is a bearish reversal pattern.

Potential Price Target:
1) Compute the height of the pattern: The distance between the highest high of peaks (which serves as the resistance) and the lowest low of the troughs (i.e. the Confirmation Point, which serves as the key support).
2) To compute the potential price target: Subtract the result from the Confirmation Point (i.e. the lowest low of the troughs).

In general, any price target should only be used as a rough guide. To determine the price target, other factors, such as previous support / resistance levels, Fibonacci retracements, or long-term moving averages, should be considered as well.

Return to Breakout Level:
After the breakout occurs, it is common that prices may return to the breakout level for an immediate test of this new resistance level before continuing their moves in the direction of the breakout. (Remember that the support now has become a new resistance level).
This could actually offer an opportunity to participate in the breakout with a better reward to risk ratio.

To find out more about other Chart Patterns, please refer to:
Learning Charts Patterns

Analysis Tool:
Get Free Trend Analysis for your favorite symbols

Related Topics:
* Learning Candlestick Charts
* Options Trading Basic – Part 1
* Options Trading Basic – Part 2
* Understanding Option Greek
* Understanding Implied Volatility (IV)
* Understanding Option’s Time Value

Sunday, August 16, 2009

TRIPLE TOP PATTERN – Part 1: Formation

Triple Top Pattern is a bearish reversal pattern that normally forms after an extended uptrend, which marks a shift in trend from bullish to bearish.

The Formation of Triple Top Pattern



Triple Top Pattern contains three consecutive, distinct & sharp peaks / tops at about the same price level, with moderate troughs in between the peaks, followed by a breakout through a support.
This pattern forms when the price is in an existing uptrend. It occurs when the price increases to a resistance level (forming the 1st peak), then decline (forming the 1st trough), and then return to the resistance level (forming the 2nd peak), then decline again (forming the 2nd trough), and then return to the resistance level again (forming the 3rd peak), before subsequently decline further.

Although the price peaks do not necessarily need to be exactly the same, but it should appear near the same price level.

The pattern is completed and confirmed when the price declines and closes below the lowest low of the two troughs, which serves as the key support level in this pattern. This lowest point is called the “Confirmation Point”.

This pattern occurs because the buyers attempt to push the price higher, but are not able to do so as they are facing resistance, which prevents the continuation of the uptrend. After three failed attempts, the buyers in the market exhausted and gave up, and the sellers begin to be more aggressive to take control of the market and drive the price lower, sending it down into a new downtrend.

To be continued to Part 2: Important Characteristics of Triple Top pattern.

To find out more about other Chart Patterns, please refer to:
Learning Charts Patterns

Analysis Tool:
Get Free Trend Analysis for your favorite symbols

Related Topics:
* Learning Candlestick Charts
* Options Trading Basic – Part 1
* Options Trading Basic – Part 2
* Understanding Option Greek
* Understanding Implied Volatility (IV)
* Understanding Option’s Time Value

Sunday, August 9, 2009

Trailing Stop Order

Trailing Stop Order is a Stop Order that continually adjusts the Stop Price as the market price of the security moves (i.e. trailing the security’s market price).
The Trailing Stop Price is placed at a set distance (either as an absolute dollar or as a percentage of the market price) below or above the market price, depending on whether it’s on a long or short position.
The Trailing Stop Price will then adjust as the market price of the security moves, maintaining the set distance.

If the market price hits or passes through the Stop Price, the order would convert into a Market Order, and will be filled at the best available price in the market at that time.
The same advantage & disadvantage of Market Order apply to Trailing Stop Order as well.

The advantage of Trailing Stop Order is that it can allow traders/investors to let the profits run (as long as the price does not fall to the Stop Price), while at the same time, limit the losses without continually having to adjust and place new Stop Loss orders.

Depending on the position on the market you have (long or short), there are 2 types of Trailing Stop Order:
a) Sell Trailing Stop Order (Trailing Stop to Sell)
This is the trailing stop order when you have a long position on a security.
In this case, the Trailing Stop Price is placed at a set distance (either as an absolute dollar or as a percentage of the market price) below current market price of the security.

The Stop Price will then rise as the market price increases (i.e. The Stop Price will be trailing the increasing market price from below: Stop Price = Increasing Market Price – Trailing Amount).
However, the Stop Price will remain the same (will not go lower) when the market price decreases.
Once the market price hits or passes through Stop Price, the order would convert into a Market Order to sell the security at the best available price in the market at that time.

b) Buy Trailing Stop Order (Trailing Stop to Buy)
This is the trailing stop order when you have a short position on a security.
In this case, the Trailing Stop Price is placed at a set distance (either as an absolute dollar or as a percentage of the market price) above current market price of the security.

The Stop Price will then move lower as the market price decreases (i.e. The Stop Price will be trailing the decreasing market price from above: Stop Price = Decreasing Market Price + Trailing Amount).
However, the Stop Price will remain the same (will not go higher) when the market price increases.
Once the market price hits or passes through Stop Price, the order would convert into a Market Order to buy the security at the best available price in the market at that time.

Note:
When placing Trailing Stop Order for an Option, the order will be triggered based on the market price of the option, NOT the market price of the underlying stock. Therefore, the Stop Price should be set based on the option’s price as well.

Therefore, just remember how the price of Call and Put options are related to the underlying stock price:
For a Call option, the option’s price increases when the underlying stock’s price increases, and decreases when the underlying stock’s price decreases (positive relationship).
On the other hand, for a Put option, the option’s price increases when the underlying stock’s price decreases, and decreases as the underlying stock’s price increases (negative relationship).

Example – Trailing Stop as an Absolute Dollar:
Suppose the stock price ABC is on a downtrend. You expect that the stock price ABC will continue to drop further. You bought Put option contracts of that stock at $3/contract, and place a Sell Trailing Stop order, with an absolute Trailing Amount at $0.5. That means the initial Stop Price is set at $2.5.
When the stock price ABC is falling and, as a result, the price of the Put option has increased to $4, the Stop Price will adjust accordingly to $3.5.
If the stock price ABC continues to drop further, and the price of the Put option then rises to $5, the Stop Price will adjust to $4.5.
Suddenly, the stock price ABC stops to drop and begins to increase. Consequently, the Put option’s price will drop. In this case, the Stop Price will remain at $4.5.
Once the Stop Price of $4.5 is hit, the order will convert into a Market Order to sell the Put option contracts at the best available price in the market at that time.

Example – Trailing Stop as a Percentage:
Similar as above, except that you place a Sell Trailing Stop order as Trailing Percentage at 20%.
In this case, the initial Stop Price will be set at $2.4 (= 3 – 20% x 3 = 3 – 0.6).
When the stock price ABC is falling and, as a result, the price of the Put option has increased to $4, the Stop Price will adjust accordingly to $3.2 (=4 – 20% x 4 = 4 – 0.8).
If the stock price ABC continues to drop further, and the price of the Put option then rises to $5, the Stop Price will adjust to $4 (= 5 – 20% x 5 = 5 – 1).
Suddenly, the stock price ABC stops to drop and begins to increase. Consequently, the Put option’s price will drop. In this case, the Stop Price will remain at $4.
Once the Stop Price of $4 is hit, the order will convert into a Market Order to sell the Put option contracts at the best available price in the market at that time.

As you can see here, when setting Trailing Stop as a percentage, the Trailing Amount will get bigger as the Market Price of the security increases.
On the other hand, when setting Trailing Stop as an absolute dollar, the Trailing Amount will remain the same.

For the list of other types of order, go to: Types of Orders in Trading.

Related Topics:
* Free Trading Educational Video: Learn Technical Tips from Dan Gramza
* Option Greek
* Understanding Implied Volatility (IV)
* Understanding Option’s Time Value
* Learning Candlestick Charts
* Learning Charts Patterns