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How to Trade the Head and Shoulders Pattern 2

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In yesterday’s lesson we looked at the head and shoulders pattern and the reverse head and shoulders pattern; two reversal patterns that you look for at the end of up trends and the end of down trends to signal their reversal. In today’s lesson we are going to look at a specific strategy with entry and exit points for how to trade those chart patterns. So let’s get started.

Let’s start by looking at the strategy for trading the head and shoulders pattern. There’s our head and shoulders pattern that we looked at in the last lesson and the basic strategy here is we’re going trade the break of the neckline. If you remember from our last lesson, once the neckline is broken the pattern is said to be in place. And if you’re looking at an uptrend there and you see that then there’s a good indication there on the break of that neckline and the formation of the head and shoulders pattern that that trend is going to reverse. So we’re going to look to enter short on the break of the neckline.

The target for the trade we are going to get by measuring the distance from the head of the pattern to the neckline, then we’re going to project that down from the break point of the neckline. So after entering the trade on the break, we are going to place our stop-loss just above that right hand shoulder there which is considered the closest resistance.

So, you can see there how we are trading the break of support and then we’re placing our stop-loss just above the nearest resistance level. So let’s look at it here. So we get 430 points by measuring the distance there. We project that downward. After entering on the break, 430 point target there.

We place our stop-loss just above the right hand shoulder. For further confirmation that this is a good trade or a good pattern to enter on, traders are going to look at two things. Firstly, they are going to look for a downward sloping neckline that you can see here.

We have in this pattern as this is further indication that the market is reversing. If that neckline was upward sloping than that would be a sign that this might not be a good pattern to trade this time but since its downward sloping, it looks like it’s a good one to trade.

The second thing they are going to look for is declining volume on each of the rises up. So volume on the head should be lower than volume on the first shoulder. And volume on the right hand shoulder should be lower than the volume going up into the head.

Lastly, traders are going to look for increasing volume on that break of the neckline to verify that that’s a valid break of the support line there. OK, the reverse head and shoulders is basically the mirror image of the opposite of the head and shoulders.

We also are going to get our projected target by measuring the distance from the head to the neckline. We enter on the break there of the resistance this time since we’re flipped upside down.

Project our 610 point target from the break of the resistance line or the neckline there. And then put our stop-loss just above the right hand shoulder there as that is considered the nearest support level.

You can see how that’s sort of a flip or a mirror image of the head and shoulders pattern. Similarly to the head and shoulders pattern, on the reverse head and shoulders pattern traders are going to look for decreasing volume going into the head and then decreasing volume again going into the right hand shoulder.

And this time instead of a downward sloping neckline we are going to look for an upward sloping neckline to indicate and give us further confirmation that the pattern is in place and this might be a good pattern to trade.

Also similarly to the head and shoulders pattern we are going to look for increasing volume on the break of the neckline as further confirmation that that is a true break there. So that’s our lesson for today.

You should have a good understanding of the head and shoulders pattern and the reverse head and shoulders pattern as well as the strategy for trading each of them.

In our next lesson we are going to finish up on reversal patterns by looking at the rising wedge and falling wedge patterns and then we are going to move on to continuation patterns after that.

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The 4th lesson in a series on charting patterns which looks at how to trade the head and shoulders pattern and the reverse had and shoulders pattern for daytraders.

How to Trade the Wedge Chart Pattern Like a Pro

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In our last lesson, we looked at specific strategies for trading the head and shoulders pattern and the reverse head and shoulders pattern, two patterns which can be considered reversal patterns when they show upon a chart. In today’s lesson, we’re going to look at something which is known as the wedge pattern, which is unique in the sense that it can be considered either a reversal or a continuation pattern depending on the shape of the pattern and whether it occurs in an uptrend or a downtrend. So let’s get started.

We’re going to start this one out by looking at the falling wedge pattern which is characterized by a pattern which forms when the market makes lower lows and lower highs, with a contracting range. When you find this pattern in a downtrend it’s considered a reversal pattern as the contraction of the range indicates the downtrend is losing steam. When you find this pattern in an uptrend, it is considered a bullish pattern as the market becomes narrower into the correction, indicating that it is running out of steam and the resumption of the uptrend is in the making.

You see here a chart of the dollar index. And you see the downtrend in place there. You can see the falling wedge in place there. And you can see the two lines, the two trend lines coming together as the pattern or the market continues into the downtrend, indicating a contraction of the range and a potential reversal there — which we did actually get, in this instance.

On the opposite side of that, you see the uptrend on the left hand side of the chart here. You see the falling wedge there. You see the contraction of the trend lines on one another, indicating the correction narrowing into the bottom there and indicating a potential continuation of the uptrend. So the market corrects then turns back around into the original uptrend. So you can see why it’s considered a continuation pattern there.

The rising wedge pattern, on the other hand, is characterizes by a pattern which forms when the market makes higher highs and higher lows with a contracting range. When you find this pattern in an uptrend it’s considered a reversal pattern as the contraction of the range indicates that the uptrend is losing steam. When you find this pattern in a downtrend it’s considered a bullish pattern as the market becomes narrower into the correction, indicating that the correction’s running out of steam, and the resumption of the downtrend is in the making.

See here rising wedge. See the start of the downtrend to the left of that. See the break below in the continuation of the downtrend on that. You see the contraction of the two lines together, two lines coming together there. Contraction of the market trend indicating it’s losing steam or that the correction is losing steam and a resumption of the downtrend.

Here we have the uptrend in place. On the left hand side of the chart we see the rising wedge. At the top of that indicating that uptrend is losing steam. And we see the reversal actually coming into play there, as well on this one.

So that’s our lesson for today. You should now have a good understanding of the falling and rising wedge patterns in situations which they’re considered a reversal pattern and continuation pattern.

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The 5th lesson in a series on charting patterns which goes over the rising and falling wedge patterns.

How to Trade the Flag/Pennant Patterns Like a Pro 2

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In our last lesson we looked at the flag and pennant chart patterns, two patterns which can be considered continuation patterns when they show up on a chart. In today’s lesson we’re going to look at specific strategies for trading each of these patterns complete with entry and exit points. So, let’s get started.

When you spot a flag pattern in an up trend, this is a bullish sign as the market consolidation which forms the flag is seen as a pause before a resumption of the original up trend. As this is the case when traders spot flags in up trends, they’re going to commonly look to enter a long position.

The point at which they’re going to look to get long is going to be the break point of the upper resistance line of the flag and then the target for the trade is calculated by measuring the flag pole or the distance between the high point of the run up and the low point of the run up that forms the flag and then projecting that distance upward from the break of the top resistance line, alright? The stop is then placed just below the bottom support line of the flag.

We’ve got our chart of rim up from last lesson and we have our bull flag there that we looked at in last lesson. And, we see the break here of the upper resistance line. So, that’s where we’re going to look to get long.

The target for the trade is being calculated by measuring the distance between the top of that pattern there or the top of the run up and the bottom of the run up. You can see it starts there at the bottom with the flag pole and then you can see the top candle there in the middle of the flag.

So, we get 27 points there by subtracting 53, the low, from 80, the high. And, that’s our target for that buy. And then, we place our stop just below the support line there, OK. The strategy for trading the bull pennant is exactly the same as trading the bull flag with one exception and that’s where the stops place. So, let’s look at this.

We have our pennant here. Same thing here as far as we’re looking for a break of the upper line of the pennant just like we did with the flag we have that there. Then we look for the distance between the high point of the move up and a low point and we subtract the low point from the high point, we get three points on the move there.

That is our target for the trade. And then, the stop this time is placed just below the closest troth in the pennant pattern. So, that’s what’s considered the nearest support level there since you have the two conversing trend lines there. So, an important distinction.

OK, the bear flag strategy is similar to the bull flag strategy, it’s just flipped upside down. So, we have our bear flag here. We measure the distance, or sorry, we have the break of the bear flag to the down side, so we’re looking to get short there.

We measure the distance from the top of the move down to the bottom. And we subtract those, we get 15 points. And, that is our target from the break point down when we get short, and then we place our stop just above the resistance line. The bear pennant strategy is exactly the same as the bear flag strategy with the stop being the only exception there again. So, let’s look at this.

We have our bear pennant here. We have the break there to the down side of the pennant, so that’s where we’d look to get short. We measure the distance of the move there, that move downward that’s several candlesticks long. We get seven points is the distance there. So, that’s our target for our short trade. And then, the stop is placed just above the closest peak to the end of the pattern there.

A couple other things to keep in mind here, just as we learned in some of our other lessons, that traders often use volume for confirmation, and this is no exception. Traders like to see volume diminish as the flag and pennant patterns mature and then like to see volume increase on the break of the support or resistance line depending on whether we’re looking at a bull or bear pattern for additional confirmation that this is a good pattern to trade.

You should have a good understanding of how to recognize flag and pennants on a chart and then how to trade each of those patterns. In tomorrow’s lesson we’re going to look at another continuation pattern which is known as the triangle which is similar to the flag and pennant.

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The second lesson in a two part series on trading strategies for trading the flag and pennant chart patterns.

How to Trade the Hammer Hanging Man Candlesticks

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In our last lesson we learned about the bullish and bearish engulfing candlestick patterns. In today’s lesson I’m going to look at two more reversal patterns, which are known as the hammer and the hanging man candlestick patterns. So let’s get started.

The spinning top and doji, which we’ve studied in previous lessons, the hammer candlestick pattern is made up of one candle. The candle looks like a hammer as you can see here, as it has a long lower wick and a short body at the top of the candlestick with little or no upper wick. In order for the candle to be considered a valid hammer, most traders will say that the lower wick must be at least two times greater than the size of the body portion of the candle. And the body of the candle must be at the upper end of the trading range.

When you see the hammer form in a downtrend, this is a sign of a potential reversal in the market as the long lower wick represents a period of trading where the sellers were initially in control. But the buyers were able to reverse that control and drive prices back up to close near the high for the day. Thus the short body at the top of the candlestick there.

After seeing the pattern form in the market, most traders will wait for the next period to open higher than the close of the previous period to confirm that buyers are actually in control of the market. That’s pretty much true with any pattern that’s one candlestick. Most traders are going to wait for confirmation on the next period of trading before taking any action as a result of the pattern.

Two additional things that traders are going to look for on this one is, like some of the other patterns we’ve looked at, a long lower wick is going to increase the significance of the pattern. As well as an increase in volume on the period that forms the candle is also going to increase the significance of this pattern.

So let’s look at a chart here. You’ve got a chart of research in motion here, and we see we have a downtrend in the market. Then we have the hammer, which we can see formed here. Then we have increase in volume. On the day that formed the hammer we have the next candle, which opens higher than the close of the candle that formed the hammer. Then we do have a rally that comes after that in this specific example.

The hanging man is basically the same thing as the hammer, but instead of being found in a downtrend it’s found in an uptrend. Like the hammer pattern the hanging man has a small body near the top of the trading range, little or no upper wick, and a lower wick that is at least two times as big as the body of the candle.

Unlike the hammer, however, the selling pressure that forms the lower wick of the candle and then the candle closing in the upper end of its range is indicative more so of a sign of a potential reversal to the down side because the selling pressure is not anticipated in the uptrend.

The hammer, the selling pressure that forms a lower wick is expected because you’re in a downtrend, here the selling pressure is not expected, which forms the lower wick of the hanging man. So that’s a warning sign that there is selling pressure in the market. Especially if you’re in an overbought condition, those types of things you may start looking for a reversal there.

As with the hammer and as we said with most one-candle patterns, we’re going to wait for confirmation or most traders are going to wait for confirmation that selling pressure has in fact taken hold by watching for a lower open on the next candle. Traders are going to place additional significance on the pattern when there’s an increase in volume during the period that the hanging man forms as well as when there’s a longer wick.

Let’s take a look at an example of a chart here. We’ve got the uptrend, and then we have overbought conditions. You can see the market ran up there pretty significantly. We have the hanging man there. We don’t have an increase in volume on this one, but we do have the lower open on the next candle and an increase in volume driving that candle down lower really significantly.

A reversal pattern in play there, and obviously hindsight is 20/20 on this one. We may have missed out on that one had we been trading it live, but you can see a good example of a situation where the hanging man formed there.

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How to trade the Hammer and Hanging Man Candlestick Chart Patterns for active traders. Like the Spinning Top and Doji which we have studied in previous lessons, the Hammer candlestick pattern is made up of one candle.

The candle looks like a hammer as it has a long lower wick and a short body at the top of the candlestick with little or no upper wick. In order for a candle to be a valid hammer most traders say the lower wick must be two times greater than the size of the body potion of the candle, and the body of the candle must be at the upper end of the trading range. When you see the Hammer form in a downtrend this is a sign of a potential reversal in the market as the long lower wick represents a period of trading where the sellers were initially in control but the buyers were able to reverse that control and drive prices back up to close near the high for the day, thus the short body at the top of the candle.

After seeing this pattern form in the market most traders will wait for the next period to open higher than the close of the previous period to confirm that the buyers are actually in control. Two additional things that traders will look for to place more significance on the pattern are a long lower wick and an increase in volume for the time period that formed the hammer.

How to Trade Bollinger Bands

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In our last lesson we learned about the stochastic oscillator, an indicator which helps us gauge momentum in the market. In today’s lesson we’re going to learn about Bollinger Bands, an indicator which helps us gauge the volatility in the market, as well as how high or low prices are relative to their historical price action. So, let’s get started.

Bollinger Bands are comprised of three bands, which are referred to as the upper band, the lower band and the center band. The center band is a simple moving average which is normally set at 20 periods and the upper and lower band represent chart points that are two standard deviations away from the moving average.

Bollinger Bands are designed to give traders a feel for what the volatility is in the market and how high or low prices are relative to the recent past. The basic premise of Bollinger Bands is that prices should normally fall within two standard deviations represented by the upper and lower band of the mean, which is the center of moving average line.

As this is the case, trend reversals often occurred near the upper or lower bands. As the center line is a moving average which represents the trend in the market, this line will also frequently act as support and resistance.

The first way that traders use the indicator is to identify potential over bought and over sold places in the market by watching for touches of the upper and lower bands or trading outside of those bands which tend to represent extremes.

Although some traders in the market use a close outside the upper or lower band as buy and sell signals, John Bollinger, who developed the indicator, recommends that this method should only be traded with the confirmation of other indicators.

Outside of the fact that as we’ve talked about in previous lessons, most traders would recommend confirming signals with more than one method. With Bollinger Bands, specifically prices tend to hug or even trade outside of the upper or lower band for long periods of time, specifically in strong up trends or down trends. And that’s obviously not a situation where you want to be positioning for a reversal.

Selling the upper band at the lower band is a technique that if you are going to use, and actually a pretty good technique if used with other indicators in range band markets. OK, so that’s what we’re going to look at here.

You can see here is a chart of the QQQQs, which is the NASDAQ ETF. And you can see here we have a ranging market there. We have a trending market here. And you can see that in the ranging market, we had multiple touches of both the upper and lower band, but in the trending market it was hugging the upper band for a good portion of that time.

Now, the trade set up here, we could look at, you know, just buying or selling on a touch of the upper and lower band, but a better method would be to combine with another indicator which I’ve done with RSI here, which we learned about two lessons ago, and you can see that you’ve got a divergence here as price moves up to a new high, but RSI does not confirm.

So, that would be your sell point and then the buy point would be when the, or the close would be when the market pulls back off of the lower band because in range bound markets, we’re anticipating that a move that starts at one end of the, or one extreme, the high band is going to move all the through to the low extreme, which is going to be low band.

And so, we don’t want to get out of the trade before it’s finished following through. If it goes into a down trend, it continues to hug that bottom line, we want to be in that trade so we’re going to wait for a pull back off of the bottom Bollinger Band line.

The second method is what’s known as the Bollinger Band contraction. And in general, after there are periods of low volatility in the market, the market tends to rally rather significantly because, as we’ve learned in some of our other lessons, periods where the market doesn’t move that much up or down are an indication that neither the bulls nor the bears are winning. So, when one side does win, the market tends to move pretty dramatically in the direction of the winning side whether that be up or down.

Low volatility is obviously represented by contracting Bollinger Bands and high volatility would be represented by widening Bollinger Bands.

You can see here we have a contraction in the Bollinger Band there and then we have a break above the top Bollinger Band meaning that the buyers have won out in this situation and we have a nice run up after that.

Now, be careful when you’re trading this strategy because if you do trade this strategy because a lot of traders say that the first break above or below the Bollinger Band line tends to be a fake out. So, it actually reverses and goes in the opposite direction. A lot of traders will trade the second break to avoid getting faked out and pulled into a trade in the wrong direction.

Bollinger Bands, because they’re an indicator which is plotted on price, are just a good indicator to use with other things such as some of things that we’ve learned so far here. So, by looking at this chart and if you’ve been through some of our other lessons, you should be able to identify the double top there.

You should also be able to identify the divergence in that top, which is represented by the relative strength index meaning that not only do we have a double top, but going up into that second double top, there was a loss of momentum compared to the first top.

You can also see a touch of the Bollinger Band there and that represented a pretty good move down in the market after that.

Now, there are lots of resources out there because Bollinger Bands is one of the most popular indicators.

As always, now that we’re talking about strategies and everything, remember that trading is risky. Nobody, certainly not me, can guarantee profits. You should design your own strategies. This is just meant for information purposes. Make sure you do your homework before getting into the market and make sure that you’re only trading with risk capital and that trading fits into your investment profile, OK?

In our next lesson we’re going to learn about something called the ADX, or the Average Directional Index, which is going to help give us an indication of the strength of the trends in the market – strength and weakness of trends in the market. So, we hope to see you in that lesson.

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A Lesson on Bollinger Bands for active traders and investors using technical analysis in the forex, futures, and stock markets.

The link that I refer to on Standard Deviation is here.

In today’s lesson we are going to learn about an indicator which helps traders gauge the volatility and how current prices compare to past prices. Bollinger Bands are comprised of three bands which are referred to as the upper band, the lower band, and the center band. The middle band is a simple moving average which is normally set at 20 periods, and the upper band and lower band represent chart points that are two standard deviations away from that moving average. Example of Bollinger Bands: Bollinger bands are designed to give traders a feel for what the volatility is in the market and how high or low prices are relative to the recent past.

The basic premise of Bollinger bands is that price should normally fall within two standard deviations (represented by the upper and lower band) of the mean which is the center line moving average.

Morning/Evening Star Candlestick Pattern

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In our last lesson, we looked at the Hammer and Hanging Man Candlestick patterns; two patterns which can be considered reversible patterns when seen in an uptrend or a downtrend. In today’s lesson we’re going to look at two more reversible patterns, which are known as the Morning and Evening Star. So, let’s get started.

OK, so the Morning Star is a pattern which is made up of three candles: a long black candle followed by a short, wider black candle, which is then followed by a long white candle. In order to have a valid Morning Star formation, most traders will look for a close of the third candle that is at least half way up the body of the first candle in the pattern.

When found in a downtrend, this pattern can be seen as a powerful reversible pattern. If you look at what this represents from a supply and demand standpoint, you can understand why. What you have here is the downtrend accelerating here with the period represented by the long black bar.

And then you have a period of indecision. In this case it’s a doji, if you remember that from our previous lesson on those patterns. But it could be any short candle. It doesn’t have to be a doji. And then you have a long, white candle representing buyers taking control after that star of indecision; that star portion of the pattern.

Unlike the Hammer and the Hanging Man, which we learned about in our last lesson; as the Morning Star is a three-candle pattern, traders will, oftentimes, not wait for confirmation from the fourth candle before considering this a valid pattern.

And, in addition, traders will look to the size of the candles for an indication of how big the potential reversal might be. Basically, what they’re saying here is the larger the white and black candle, the larger the potential for reversal, and the larger that reversal may be. And the more that the white candle goes up into the body of the black candle, the greater the potential for reversal, and the larger the reversal is expected to be.

Here’s what this looks like on a chart. You can see here, we’ve got the downtrend in place. And then we have the Morning Star. Ideally, we’d like to see a little larger black candle there on the left hand side, but this is still a valid pattern here, and especially since we’ve got such a large uptake in volume on the move upward, where the buyers are taking control. That should be an eye-opener there that, potentially, something’s changing, in terms of the trend there.

The Evening Star is, basically, the exact opposite of the Morning Star. When it’s found in an uptrend, it’s considered a reversal pattern. And what you’ve got here is a long white candle showing the acceleration of the uptrend. And then a short candle, again here, it doesn’t have to be a doji, representing indecision in the market after that big upshot in the market.

And then you’ve got the long black candle, indicating that sellers are taking control of the market, and there’s a potential reversal in the making there. Here again, just like with the Morning Star, the close of the third candle needs to be at least half way down the body of the first candle.

And as with the Morning Star, as well, a lot of traders will not wait for a fourth candle for confirmation before considering this a valid pattern. And the same rules apply for the length of the candles, in terms of the potential for trend reversal, and the size of that potential reversal.

The longer the white and black candles are, the larger the potential reversal may be. And also, the more the black candle goes into the body of the white candle, the stronger the reversal is thought to, potentially, be.

OK, so, just a quick example here of the Evening Star. We’ve got an uptrend here in place. And we’ve got a three candle Evening Star pattern there, and the sell-off that occurs after that. Just as with the Morning Star, you don’t want to have volume confirmation there. And the more things you have, as with everything that we go over, confirming that there’s a potential reversal in place, the better. All right?

All right, that completes our lesson for today. In tomorrow’s lesson, we’re going to finish up our series on Candlestick Patterns, with a look at the Shooting Star and the Inverted Hammer pattern. So, we hope to see you in that lesson.

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How to trade the morning and evening star candlestick chart patterns for active traders and investors.

In our last lesson we looked at the Hammer and Hanging Man Candlestick Chart Patterns. In today’s lesson we are going to look at two more reversal candlestick patterns which are known as the Morning and Evening Star.

The Morning Star Pic The Morning Start Candlestick Pattern is made up of 3 candles normally a long black candle, followed by a short white or black candle, which is then followed by a long white candle. In order to have a valid Morning Start formation most traders will look for a close of the third candle that is at least half way up the body of the first candle in the pattern. When found in a downtrend, this pattern can be a powerful reversal pattern.

What this represents from a supply demand situation is a lot of selling into the downtrend in the period which forms the first black candle, then a period of lower trading but with a reduced range which forms the second period and then a period of trading indicating that indecision in the market, which is then followed by a large up candle representing buyers taking control of the market.

Unlike the Hammer and Hanging Man which we learned about in our last lesson, as the Morning Star is a 3 candle pattern traders often times will not wait for confirmation from the 4th candle before entering the trade.

How to Trade Stochastics

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In our last lesson, we learned about the relative strength index, and different ways that traders use this in their trade. In today’s lesson, we’re going to learn about another momentum oscillator, which is known as stochastics. So, let’s get started.

I’ll start by saying that there are three different types of stochastic oscillators: the fast stochastic, the slow stochastic, and the full stochastic. All of these operate in a similar manner, however. And when most traders refer to the stochastic, they’re talking about the slow stochastic. So, that’s going to be the focus of this lesson. The basic premise of a stochastic is that prices tend to close in the upper end of their trading range when the financial instrument you’re analyzing is in an uptrend. And in the lower end of their trading range, when the financial instrument you’re analyzing is in a downtrend.

When prices close in the upper-end of their range in an uptrend, this is, obviously, a sign that momentum of the trend is strong, and vice-versa for a downtrend. The stochastic contains two lines, which are known as the percent K line, and the percent D line.

I’m not going to go into the formulas for each, because most charting packages, if not all charting packages that you’ll use, will calculate these lines for you. However, you should know that this is a momentum oscillator. So, when the percent K line is rising, that is an indication that momentum in the market is increasing. And when the percent K line is falling, it’s an indication that momentum in the market is decreasing.

The percent D line is, very simply, a simple moving average of five periods; simple moving average of the percent K line, and it acts to smooth out the price action of the indicator, and slow it down a little bit. And also acts as a signal line for the faster, percent K line, which we’re going to learn about later in this lesson.

It’s a banded oscillator, just like the RSI, so, it fluctuates between 0 and 100. And the upper end of the range is marked by a line at 80. And the lower end of the range is marked by a line at 20. The first way that traders use this is to trade overbought and oversold levels.

George Lane, who invented the indicator, recommended waiting for a cross, back below the 80 line, when the market went from an extremely overbought area before placing a trade to the down side, and waiting for a break, back above the 20 line, before signaling a trade to the upside.

So, you see here, you have the overbought area. You have the break below the 80 line, and then you do have a sell-off that results after that. You have an oversold area here. You have a break back above the 20 line, and then you have a rally.

Again, hindsight is 20/20, and there are going to be false signals with this indicator, as with any other indicator that we’re going to look at. One of the ways to reduce the amount of false signals that you’re going to get is by combining indicators and combining methods of analysis, using some of the things that we’ve learned, so far.

Here you have a false signal. The indicator was in an overbought area, traded back below the 80 line. You did not have a sell-off after that. But hopefully, if you would have watched our lessons on trends and Dow Theory, you would have been watching this strong uptrend here, and you would have not been taken into that trade there to the downside, because there was not a break in that trend line.

Here, however, there was a break at the trend line, and you had, not only, the break of the trend line, which is a very strong signal, but also, the break back below the 80 line of the oscillator. And you did have a sell-off that resulted after that.

A second way this can be traded as crossover signals. Remember from earlier, the percent K line is the faster line. The percent D line is the slower line. So, when the percent K line crosses above the percent D line, this is an indication that it may be a good place to buy.

And when the percent K line crosses below the percent D line, this is an indication that it might be a good place to sell. This is, basically, a way for aggressive traders to catch earlier signals, particularly from overbought and oversold areas.

Here, we’ve got a Bearish cross from our overbought area. We’ve got the Bearish cross with the black line; the percent K line, and trading below the red percent D line. And we’ve got the break below 80 there.

You could have gotten in, however, earlier into the trade, had you been trading the Bearish cross from the overbought area, instead of waiting for the break. But that’s not recommended. And this indicator like the cross of the RSI is very prone to false signals. So, be careful there.

The divergence is the third way. And, very simply, when the market is making new highs, and when the market is trading in the opposite direction of the indicator, that’s an indication that a reversal may be coming. So, you have divergence here, and, as you can see, the market’s making new highs there.

But you can see by looking at the stochastic, that momentum in the market is not following upwards. So, that might be a good place to look for a sell-trade. If you remember from previous lessons, hopefully, you’ll also see something else there, which is a double top.

So, you have two things confirming that, that might be a good place to place a sell-trade. You have the divergence plus the chart pattern there; the double top. And you do have a nice sell-off that results after that.

As you probably noticed in this lesson, the stochastic oscillator is very similar to the RSI, and they’re both momentum oscillators. So, many traders will use one or the other. They’ll try out both, and figure out which one works better for them, for identifying the momentum in whatever instrument they’re trading. Another way that’s it’s used is with, in conjunction with the RSI, to confirm each other; so to confirm opinions on momentum.

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A lesson on how to trade the stochastic oscillator for active day traders and investors.

In our last lesson we learned about the RSI indicator and some of the different ways traders of the stock, futures, and forex markets use this in their trading.

In today’s lesson we are going to look at another momentum oscillator which is similar to the RSI and is called the Stochastic. Let me start by saying that there are 3 different types of stochastic oscillators: the fast, slow, and full stochastic. All of them operate in a similar manner however when most traders refer to trading using the stochastic indicator they are referring to the slow stochastic which is going to be the focus of this lesson.

The basic premise of the stochastic is that prices tend to close in the upper end of their trading range when the financial instrument you are analyzing is in an uptrend and in the lower end of their trading range when the financial instrument that you are analyzing is in a downtrend. When prices close in the upper end of their range in an uptrend this is a sign that the momentum of the trend is strong and vice versa for a downtrend.

The Stochastic Oscillator contains two lines which are plotted below the price chart and are known as the %K and %D lines. Like the RSI, the Stochastic is a banded oscillator so the %K and %D lines fluctuate between zero and 100.

How to Trade the Flag Pennant Patterns Like a Pro

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In our last lesson, we looked at strategies for trading the rising wedge and falling wedge chart patterns; two patterns which can be considered either reversal or continuation patterns, depending on how they show up on a chart.

We start our series on continuation patterns by learning about the flag and pennant patterns so that we can then look at strategies for trading each of these patterns. So let’s get started.

Flags and pennants are generally seen after a big move in one direction in a particular financial instrument and represent brief consolidations or pauses in the market before a resumption of the trend in which they occurred. The flag and pennant patterns both contain a flagpole which is represented by the sharp move upwards or downwards which sets up the consolidation. Then the flag is represented by a consolidation which can be encompassed by a rectangular formation, and a pennant is represented by a consolidation which needs to be encompassed by a triangle.

When a flag or pennant occurs in an uptrend, a break of the top resistance line can be seen or is oftentimes looked at as a resumption of the uptrend. And conversely, when a flag or pennant occurs in a downtrend, a break of the bottom support line can often be seen as a resumption of the downtrend.

So let’s look at a couple of examples here. We have a chart of Research in Motion here (RIM). Towards the right-hand side of the chart, you can see a little jump in the market there, and then the consolidation which we can encompass with two parallel lines, so that forms our flag portion of the pattern.

And then the flagpole is represented by the up move in the market, OK. so you can see the flagpole and the flag there.

Now, for flag patterns, the flag portion of the pattern can be either pointed directly to the side or slanted downward as we here; both are relevant flag patterns there and you can see the market breaking out above that and making a pretty good run after the breakout of the top of that flag pattern.

Because this flag pattern occurred in an uptrend and it was after a big jump upwards in the market, it’s known as a bull flag.

Here, we have a chart of Travel Zoo and we can see here we have our flag portion, a brief consolidation in the market after our move downward which is represented by the flagpole.

It’s basically the exact same as the bull flag example, except flipped upside down because we’re in a downtrend here, we have a big move downward, then a brief consolidation in the market before resumption of the downtrend. So you can see there.

And again here. The flag portion of the pattern can be represented by a rectangle that either points directly to the side or slightly upwards; either would be considered a valid flag pattern.

OK. So for the pennant pattern, the difference between a flag and a pennant is when a pennant is formed, the consolidation after the big move upwards or downwards narrows as it matures.

So we can see here a chart of, again, research in motion. We see a pennant formed here, and then our flagpole representing the move upward. Then we see the breakout above the top portion of the pennant.

And again here, just as with the flag, the pennant can point directly to the side or slightly downward and both would be considered valid moves there, and again here because this is an uptrend that’s represented. It’s considered a bull pennant.

OK. So here, we have a bear example. And again, just flipped upside down. Chart of Starbucks. You can see the consolidation narrowing there after the big move downward and representing the flagpole, and then you see the breakout below. OK.

You should now have a good understanding of flag and pennant patterns, and which is considered a bull flag and which is considered a bear flag, as well as with the pennants.

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In this lesson we learn about what flag and pennant patterns are in technical analysis and how to identify them on charts in the stock market, futures market, and forex market for day traders and investors.

How to Trade Double Tops Like a Pro

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In our last lesson we looked at the basics of charting patterns and two of the more common patterns you find in the market, double tops and double bottoms. In today’s lesson we’re going to look at a specific strategy that many traders use to trade these set-offs or these charting patterns complete with specific entry and exit points. So let’s get started.

The double top and the double bottom are signs that a financial instrument has failed to break through a specific level, considered resistance on the double top side and support on the double bottom side. So because of this they’re considered reversal patterns and where traders will look to these patterns or place a lot more significance on these patterns is when they’re occurring as part of an uptrend on the double top side and as part of a downtrend on the double bottom side. They’re going to look for, when they see a double top in an uptrend, they’re going to see that as a signal that the uptrend may be coming to an end and look to possibly trade that reversal. When they see a double bottom in a downtrend they’re going to look to that as a signal that the downtrend may be coming to an end and look to trade the potential reversal there.

Let’s start with a basic strategy for trading a double top. You can see the double top here forming our resistance level. The middle of the two points there, referred to as the trough, is considered our support level and so traders commonly wait for the market to pull back and break below that support level as a confirmation that the double top is actually in place.

They’re going to wait for the break there and then they’re going to enter on that break and then they’re going to measure this move here, the bottom of the trough, up to the top of the two points, and then that is going to be their profit target, OK? And then the stop loss is placed just above the second peak there. So a fairly basic strategy, but one that is commonly used to trade double tops and one that you may see a potential to use fairly often.

A second thing which traders are going to use for confirmation here is volume. I don’t actually have volume on this chart because this is an Forex chart, but if you’re trading futures or equities, you would have volume available and they’re going to look for a decrease in volume on the second peak, indicating that the buyers there driving up to the second peak were not as strong as they were into the first, and then an increase in volume on the break of the support level there indicating that that’s a true break, OK?

Double bottom strategy is the mirror image of the double top strategy. We have the double bottom in place here. We have the peak between the two double bottoms as our resistance level. We are waiting for a break to enter on the break of that resistance level as the common strategy. Measure the move there. Measure the difference between the highest trough and the middle of the peak and you get 174 points in this example. That’s the profit target.

Stop loss placed just below the lowest trough in the double bottom, OK? And again here looking for confirmation from volume. If you were looking at a stock market chart a futures market chart you would look for falling volume on the second trough that forms the double bottom and rising volume on the break of the resistance line.

OK, so you should now have a good understanding of one possible strategy for trading tops and bottoms that is commonly used in the market. In tomorrow’s lesson, we’re going to go into something which is known as head and shoulders, which is another charting pattern and lead into a potential strategy for trading that, OK? So starting to get a little interesting now with the trading strategies. Be careful when using these. A lot of practice, and make sure you understand exactly what you’re doing.

* As, the financial markets and trading in general is very risky, you should only trade with risk capital, money that you can afford to lose, and there’s no system or strategy that’s going to win all the time or that can guarantee profits or anything like that, so make sure you do your homework. As always, if you have any questions or comments, please feel free to leave them in the comments section below and have a great day.

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The 2nd lesson in a series on charting patterns for traders and investors in which goes into specific strategies which can be used to trade double tops and double bottoms in the Forex market, stock market, and futures market.